Welcome to the Caesarstone first quarter 2017 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Alison Kane of ICR. Thank you, Ms. Kane. You may begin.
Thank you, operator, and good morning to everyone. Certain statements in today's conference call and responses to various questions may constitute forward-looking statements. We caution you that such statements reflect only the company's current expectations and that the actual events or results may differ materially. For more information, please refer to the risk factors contained in the company's most recent annual report on Form 20-F and subsequent filings with the Securities and Exchange Commission. In addition, the company will make reference to certain non-GAAP financial measures, including adjusted net income, adjusted net income per share, and adjusted EBITDA. The reconciliation of these non-GAAP measures to the most directly comparable GAAP measures can be found in the company's first quarter 2017 earnings release, which is posted on the company's investor relations website. With that, I'd like to now turn the call over to Raanan Zilberman, Chief Executive Officer of Caesarstone.
Raanan, please go ahead.
Thank you, Alison. Good day, everybody, and welcome to our conference call. This is my first quarterly call as the Chief Executive of Caesarstone, and I would like to thank you for joining us today. I'm looking forward to meeting many of you in person in the near future. I'm pleased to report that we have begun 2017 with a strong first quarter. Here are a few highlights from the quarter. Our global sales increased by 17% to $130 million, compared to $117 million in last year's opening quarter. Without currency impact, growth would have been 15%. Our adjusted EBITDA for the first quarter was $24 million, up by 6% year-over-year. This is a margin of 18%. Our adjusted net income was $30 million, and adjusted EPS was $0.36. Now I would like to provide an update on each of our regions.
We had a strong first quarter to the year in the U.S. Our revenue was up by 17.7% to $58 million, compared to $49.3 million last year. We were pleased with our growth both in our core business and IKEA. In the U.S., we certainly need to stay focused and continue to execute well to ensure that we translate our opportunities into revenue growth. In Australia, sales in the first quarter were $29.5 million, up by 14.8% compared to $25.7 million last year. On a constant currency basis, Australia was up by 9% in the first quarter, still strong given the ongoing soft housing condition. Our team in Australia is continuing to do an excellent job of using Caesarstone's dominant market position and strong brand to push the business forward.
Canada sales in the first quarter grew at a good pace of 26.4% to $22.3 million against last year's $17.6 million. On a constant currency basis, growth in Canada was 22.2%, with a boost from good IKEA business. It is worth mentioning that since Q1 2015, we grew in Canada by over 70% on a constant currency basis, with significant growth coming both from the core market and from our relationship with IKEA. Sales in Israel for the quarter were $11.7 million, up by 13.8% compared to last year. On a constant currency basis, sales were up by 7.4%. While Israel is the most mature of our markets, we continue to leverage our premium brand position, and this is nice. Europe sales in the first quarter were $6.4 million, down by 2.8% compared to last year. On a constant currency basis, sales were down by 0.3%.
Following the transition to direct distribution in the U.K., we have seen a significant increase in revenue, although we have started from a low base. We are looking forward to growing the business further. Revenue in the rest of the world grew at a rate of 15% to $8.5 million, compared to $7.4 million last year. On a constant currency basis, revenue grew was 17.6%. In Richmond Hill, our U.S. plant, we have now seen six months of consistent improvement in volume and in yield. That said, we still have work to do, and we need to continue and improve our processes in the plant. To sum it up, this was a solid quarter for the company. We are in a process of strengthening our position, and we remain confident of delivering the 8%-10% top-line growth target. In Q1, we indeed deliver 17% revenue growth.
That is nice. We believe that Q2 will be a little bit more moderate and will bring the first half of the year to an annual growth of 8%-10%. I would like to share a few general thoughts about the company after a few short months as the chief executive officer. First, the market. I see a very strong fundamentals to support the business. There is a solid and growing demand for quartz on a global basis, which represent a future opportunity for growth. Second, the company DNA. I've joined a company that is a true leader in its industry. It is now for a decade that Caesarstone continues to stay in the forefront in terms of innovation, technology, and design. Third, the brand. The company has done an amazing job in building a world-class brand that has inspired consumers around the world.
At last, and maybe most important of all, the team. I am surrounded by experienced, talented, and motivated people. Indeed, like any business, we have challenges. However, the opportunities in front of us are tremendous, and I am excited. We are well-positioned and driven to succeed, and with hard work and focus, I am confident that we can deliver value to our shareholders. I would like to turn now the call over to Yair, our CFO, for a closer look at our financial results. Yair.
Thank you, Raanan, and good morning to everyone. I will start with our income statement for the first quarter. Global sales in the first quarter increased by 16.7% to $136.4 million, compared to $116.9 million in the first quarter of last year. On a constant currency basis, sales increased by 14.5%. Gross profit in the quarter increased by $6.6 million compared to last year. Gross margin was 36.1% compared to 36.5% last year. The slight decrease in margin was driven primarily by higher manufacturing costs in Israel, related mainly to new product introduction, a higher portion of revenue from IKEA, which incorporates a low-margin fabrication and installation component, and an increase of raw material cost. Those drivers were partially offset by favorable product mix and positive exchange rate fluctuations.
Operating expenses in the first quarter were $34.1 million, or 25% of sales, versus $28.4 million last year, which was 24.3% of sales. The increase in operating expenses as a percent of sales primarily reflects our investment in improving sales and marketing capabilities, particularly in the U.S., as well as the shift to direct distribution in the U.K. First quarter operating income was $15.1 million, up from $14.2 million in the first quarter last year. Adjusted EBITDA in the first quarter, which eliminates share-based compensation, legal settlements and loss contingency expenses, and other non-recurring items, was $24.3 million, a margin of 17.8%. This is an increase of $1.3 million relative to last year, but with lower margin, primarily the results of the investment we have made in marketing and sales.
Finance expenses in the first quarter was $1.5 million, compared with finance income of $0.2 million in the same quarter of last year. This swing was primarily due to net losses related to currency exchange rate fluctuation relative to net gain last year. Our taxes in the first quarter were $2.3 million, 17.2% of income before taxes, compared to a 16.4% rate last year. Despite the decline in tax rates in Israel, we were impacted by increase in volume production in Richmond Hill with its higher tax bracket, and by increased taxable income in our distribution subsidiaries, where tax rates are higher. Adjusted net income attributable to controlling interest in the first quarter was $12.5 million, compared to $13.3 million last year. This decline was mainly a result of the swing in finance expenses. Adjusted diluted earnings per share in the quarter were $0.36 on 34.4 million shares.
Adjusted diluted earnings per share last year were $0.38 on 35.4 million shares. Turning to our March 31st balance sheet. We had cash equivalent, and short-term bank deposits of $121 million. This compares favorably to $106 million at year-end. During the quarter, we generated $13 million in free cash flow. Our cash balance is roughly double the level reported at the same period last year, even after the execution of our share repurchase program. With respect to our 2017 guidance, we are pleased with the first quarter results. However, we need to continue to make progress, and market conditions remain fluid. Therefore, we are maintaining our guidance for the full year of 2017. Our revenue guidance for the year remains $580 million-$595 million, and our expected range of adjusted EBITDA for the year remains $119 million-$126 million.
We would like to note that we are expecting the second quarter year-over-year growth to be lower than the growth in the first quarter, potentially low single-digit growth. For the most part, this is related to a tough comparison versus a strong second quarter last year, and an IKEA comparison. Thank you. Now we are ready to open the call for questions.
Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press *1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press *2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Our first question comes from Michael Rehaut with JPMorgan. Please proceed with your question.
Hi. Thanks. Good morning, everyone, welcome to Raanan. Looking forward to meeting you next week, I can already tell you're a great marketer because of the anticipation that you've built on your arrival.
Thank you, Mike.
First question, Raanan, you kind of mentioned some of your early observations with the company and maybe without getting too far ahead of yourself, I was curious on your initial thoughts, if possible, around the U.S. market, which is obviously the key market for you in terms of a growth opportunity going forward. What are your initial impressions in terms of your competitive position in particular? There's obviously a few good competitors out there and a lot of product innovation across the industry. How do you think about maybe how you want to lay out the priorities in terms of a growth strategy, particularly around brand and product differentiation?
That's a tough one, Mike. Anyway, thank you for the-
I apologize if it's, again, a little maybe premature to answer this, I guess any initial thoughts?
I'll try to cope with it. First of all, before we dive to the U.S., I'd like to say something in general for the company, okay? Because U.S. is a second derivative of the challenges that we have. In general, as you know, Caesarstone was established as a manufacturer, a plant with a very innovative product. Over the years, it started to buy and consolidate sales channels and developed a premium leading brand. I believe that the company should continue the journey into the same direction and increase its proximity and relationship with its customer. In other words, I would like to see the center of gravity of the company continuing to shift from an industrial organization to a world-class commercial organization. Along this journey, we need to use our unique and special tools, which are innovation, premium brand, and experienced and motivated team
This is an umbrella, okay, Mike? It is relevant for every region, but I think it's a kind of a statement of what I would like to see in the U.S., a world-class commercial organization. If we drill down to the U.S., at this moment, I'd like to say that we are pleased to see the business perform well in the first quarter. That said, it's still not consistent enough to draw a conclusion for me. I do believe that there is a good opportunity for us in the U.S. It's our biggest market. There is a clear and solid demand for quartz, and we just need to come to the party. Basically, I see four fundamentals that need to be in place to continue and capture growth in the U.S.
One is a good plan, two is relevant resources, three it's a solid team with a drive, and four, very high level of execution. Together with the U.S. leadership team, we will be closely and carefully reviewing and managing the different elements to ensure that we leverage on the opportunity that we have in the markets. As I said, you have the umbrella. We're working on the four elements. We are coming to the money time when it is about execution. I hope it gives you a little bit of my first thoughts, Mike.
No, that's perfect, Raanan. I appreciate those comments. Secondly, for Yair, you mentioned, low single-digit growth potentially in the second quarter, and I guess getting the first half in line with the full year growth outlook of 8%-10%. You mentioned, Yair, a tougher comparison in the second quarter. If I drill down and look at the U.S. and Canada in particular, the U.S., the comparison is similar. It's 5% versus 3% in the first quarter. Canada is actually pretty similar, and a little easier on excluding currency. I was just curious if there's other things going on, perhaps that helped the first quarter that might hurt the first quarter.
I don't know if there was any pull forward of demand, if there were some new product roll-outs or other things that is causing this expected slower growth in the second quarter, because the comps do look a little more on a similar basis, at least for a couple of your bigger regions.
Okay, Mike. I look at it a little bit differently. I'm comparing Q2 to Q3, normally we expect Q3 to be our peak quarter, and it has been traditionally the story of Caesarstone.
Last year in North America, in Q3 in both regions, we did in Q2 better than in Q3, which is quite unusual in terms of seasonality for the company. Indeed, last year, Q2 was very strong in seasonality, and this year it's more back to our historical rates, where Q3 is the peak.
Thank you. Our next question comes from John Baugh with Stifel. Please proceed with your question.
Thank you for taking my questions, and welcome, Raanan. Look forward to meeting you next week. I was curious, maybe following up on that question, if you could comment just on the core business. I appreciate IKEA could be lumpy, and I believe there's a Canadian lapping going on with IKEA here. Is there any change to the tone of the core business, as you see it, or was there some lumpiness there that is explained by something other than normal demand?
Okay. In Q1, IKEA, as we alluded before, should have been an easy comp, and indeed, it was an easy comp. IKEA in both U.S. and Canada grew significantly. However, the core growth was very strong as well.
Okay. I guess my question, Yair, is as you look at, you've got April in the books, as you look at Q2, is there much of a change from the pace in the core business from Q1?
Okay. I will start with IKEA first. IKEA, certainly the year-over-year growth will decline significantly, because it's a different comp. The resumption of the promotional event last year. We are in a more reasonable comparison as far as IKEA. In the core growth, we expect to grow in both regions. Again, the comparison is not as easy compared to last year in Q2 than in Q1.
Okay. Thank you.
In other words, as Raanan said it, back to Raanan's statement, which I think just another easy way to look at it. Taking together Q1 and Q2, we see the first half as a normalized growth for overall the global company and North America.
Okay. We try to parse out your commentary about Richmond Hill and the production. I appreciate you're not going to give us volumes and yields or scrap rates or whatever, but my recollection was you pulled down one line in the fourth quarter and restarted that line after tinkering with the one line and getting it to where you wanted. Is there any additional color you can give us that gives us comfort about where you are in the process of continuing to improve volume or yield or both?
John, this is Raanan. Yes, in general, I think that we are in a good direction. There is certainly some good news coming from Richmond Hill. Over the last six months, we have made consistent progress in the plant. This is reflected clearly in both quantities and the yield. That said, it's important that we continue to improve. We have a detailed plan in place, and we are strictly following and monitoring. We are working on both of the lines, and we are on a consistent base, ramping up the capacity. All in all, it was a good quarter for Richmond Hill.
Okay. No concerns about, at this point, the production you need out of there to hit the annual guidance on revenue?
I think it will be the destiny of the industry. We will run always after the demand. This is the good news and the bad news together. We are living in an industry that is growing, and we will need to keep on developing the demand. I can tell you that the company is already dealing with discussion and thoughts, what and where will be our next move.
Okay. Any update on Lowe's and how that program is going?
Yeah, Lowe's, we started a few initial deliveries in Q1. We are already in around 200 stores in few of the states that Lowe's selected as the first step. In terms of revenue, it was immaterial for the quarter.
Great. I'll defer to others. Thank you so much.
Thank you.
We're looking forward for this business to develop. It's just a matter of time, I believe.
Thank you. Once again, if you would like to ask a question, please press star one on your telephone keypad. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our next question comes from the line of Lena Rogova with Chardan Capital Markets. Please proceed with your question.
Good afternoon. Congratulations on strong revenue growth, Raanan. Welcome and good luck. One of my questions has been already answered, so my remaining question is about the new product, which is being manufactured in Israel. Could you provide some more details about what it is and what pressure on margin should we expect in the coming quarters, if any? Thank you.
Yes. In the first quarter, we did engage the lines in Israel in full production of new SKUs that we believe are important for us, for our position, for our differentiation. Over time, it's a necessary step for us. There was some hiccups. It's always not trivial to start new models, and they are getting more and more complicated, and it takes time to bring them to speed. We paid a bit for that in Q1. We believe that we'll improve the throughput in the outer quarters. We believe that for the long time, it's what we need to do.
Thank you. Is it the product being sold in Israel or across your geographies?
We started those in Israel, and the rest is all tactical optimization and where we prefer to produce anything where the demand is. It depends, but we started them in Israel this time.
Okay. Thank you.
Thank you. There are no further questions at this time. I would like to turn the call back over to Raanan Zilberman for closing remarks.
Thank you, Alison, and thank you, gentlemen and ladies, for your attention today. To quickly summarize, I would say that we are very pleased with the first quarter results. Nevertheless, we know that we need to continue to execute well. Personally, I'm looking forward to meeting you soon again. Take care, and have a good day.
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.